Trusts explained

Many people assume Trusts are only used by the super-rich to manage their fortunes. In fact, a Trust is a valuable tool to manage even a relatively modest level of wealth. If you have a property, shares and a pension pot, for instance, a Trust may well be the ideal way of ensuring that it is used to best effect, either during your lifetime or after your death.

There are many different types of Trust available for different purposes, so we thought we’d give a quick overview of them below.

What Is a Trust?

The definition of a Trust is fairly straightforward: it is a legal arrangement by which one person (the settlor) transfers assets to a small group of people (the trustees), who are legally obliged — with varying extents of discretion — to administer them on behalf of one or more others (the beneficiaries).

The assets are referred to as a Trust Fund and the terms of the Trust are set out in a Trust Deed.

The Trust Fund is legally owned by the trustees (one of whom may or may not be the settlor) but without any legal right to benefit from it. The settlor can either establish the Trust during their own lifetime, or else make provision in their Will for it to be activated after their death.

So, what types of Trust are available, and how do they differ?

Bare Trust

Also sometimes known as a simple or absolute Trust, a Bare Trust is the most straightforward type. Under this, assets with a set value are held by the trustees, who have no discretion over how to manage them. The contents of the Trust Fund will be paid in full to the beneficiaries at a predetermined point, often (but not necessarily) when they reach the age of eighteen.

The most common use of a Bare Trust is to make provision in your Will for your children (you can read more about this in our ‘What is a Will Trust‘ article). In this case, each will receive their share of the assets either on their eighteenth birthday or at another specified date. For example, you may be worried about a teenager having access to these funds and decide instead that they should wait till a later birthday. However, you cannot legally set a date while they are still children.

A variation of the Bare Trust is the Fixed Trust. This allows you to have the assets paid in set proportions, rather than set amounts. Whereas in setting up a Bare Trust it is essential to know the exact sum available, this is not necessary for a Fixed Trust, where, for instance, assets may include shares.

Interest in Possession Trusts

An Interest in Possession Trust is one where the beneficiaries have no right to the capital in the Trust Fund, but are entitled to receive income. This may, for instance, include income from shares or rent from a property, but the beneficiaries would have no legal right to sell the shares or property.

This type of Trust may be arranged in various ways. If, for example, you make your partner the main beneficiary, they will receive the income for the rest of their life.

On their death, this arrangement may be passed on to your children, who will become income beneficiaries, or the Trust may be wound up at that point. This is called a Life Interest Trust, and the designated heirs (such as your children) will become capital beneficiaries and between them receive the total capital.

Discretionary Trusts

A Discretionary Trust is one in which the trustees are given discretion, within limits set out in the Trust Deed, on how to manage both the capital and the payments.

For instance, they may be given discretion to make choices about how to invest the assets in the Trust Fund in order to generate extra value, or even to sell the assets and convert them to income. They may also be able to make various decisions about payments, including:

• what to pay out
• which beneficiaries receive the payments
• the frequency of the payments
• whether to impose conditions on the beneficiaries

Discretionary Trusts are often used to make long-term provision for someone who may not be able to make responsible decisions on a permanent basis. For example, if someone receives compensation for brain damage that leaves them without mental capacity (including Medical Negligence during the birth process), that may be placed in a Discretionary Trust. This will enable the trustees to plan for the beneficiary’s lifetime needs.

In some cases, a Discretionary Trust may be set up allowing income to be added to the capital, where appropriate. In this case, it is called an Accumulation Trust.

Settlor-interested Trusts

This refers not so much to a specific type of Trust as to the situation in which the settlor or their legal partner is also a beneficiary of the Trust. As such, it can be a Discretionary, Accumulation or Interest in Possession Trust.

A typical example of a situation in which a settlor-interested Trust would be appropriate is in the event that you had received compensation for an accident or case of Medical Negligence which had left you with difficulties in earning a living but still able to manage your affairs. This would mean that you could act as settlor in setting up the Trust, and also be the beneficiary in receiving a regular income for the rest of your life.

Setting up a Trust is a complex legal process, and the only way to be sure you have chosen the most appropriate type is to discuss it with a specialist Trusts solicitor.

If you are considering establishing a Trust and are unsure of how to proceed, get in touch with our Trusts specialists today either by calling us on 01525 378 177 or via online.